What is called “capitalism” is best
understood as a series of stages. Industrial capitalism has given way to
finance capitalism, which has passed through pension fund capitalism since the 1950s and a
US-centered monetary imperialism since 1971, when the fiat dollar (created
mainly to finance US global military spending) became the world’s monetary base.
Fiat dollar credit made possible the bubble economy after 1980, and its sub-stage
of casino capitalism. These economically radioactive decay stages resolved into
debt deflation after 2008, and are now settling into a leaden debt peonage and
the austerity of neo-serfdom.

The end product of today’s Western
capitalism is a neo-rentier economy — precisely what industrial
capitalism and classical economists set out to replace during the Progressive
Era from the late 19th to early 20th century. A financial class has usurped the
role that landlords used to play — a class living off special privilege. Most
economic rent is now paid out as interest. This rake-off interrupts the
circular flow between production and consumption, causing economic shrinkage —
a dynamic that is the opposite of industrial capitalism’s original impulse. The
“miracle of compound interest,” reinforced now by fiat credit creation, is cannibalizing
industrial capital as well as the returns to labor.

The political thrust of industrial
capitalism was toward democratic parliamentary reform to break the stranglehold
of landlords on national tax systems. But today’s finance capital is inherently
oligarchic. It seeks to capture the government — first and foremost the
treasury, central bank, and courts — to enrich (indeed, to bail out) and untax the banking and financial sector and its major
clients: real estate and monopolies. This is why financial “technocrats” (proxies
and factotums for high finance) were imposed in Greece, and why Germany opposed
a public referendum on the European Central Bank’s austerity program.

“THE
FUTURE OF CAPITALISM”— WHAT KIND OF CAPITALISM DO WE MEAN?

What is so striking in the recent debates
about the future of capitalism is confusion about just what kind of capitalism
is being talked about. Most people have in mind industrial capitalism’s
tangible investment in plant and equipment, employing labor to produce output at
a markup (profit). But the Western world is now on a path of economic
austerity, shrinking employment and downsizing. Corporations are using their
cash flow and borrowing mainly for stock buybacks, debt-leveraged privatization
of public assets, and buyouts of assets already in place. Banks are lending
mainly to other financial institutions, not to investors or consumers, and most
credit growth is for speculating in foreign exchange and interest rate arbitrage.

This is not what was envisioned when the
Industrial Revolution was peaking in the 19th and early 20th century. To expand
markets and increase their economies’ competitive pricing position, classical
economists sought to free their societies from the legacies of feudalism — a
landed aristocracy extracting land rent, and a banking class extracting
interest and converting national debts into the creation of monopoly trading privileges.
Progressive Era reformers accordingly defined a free market as one with a
government strong enough to tax away land rent and either break up monopolies
or keep them in the public domain. The aim was to bring market prices in line
with minimum necessary cost-value. This required a strong
enough government to tax and check the vested financial, insurance, and
real estate (FIRE) interests.

When Joseph Schumpeter spoke about
creative destruction, he was referring to innovations that raised productivity,
enabling new companies to unseat the old by lowering costs below those of
competitors. The main change that he envisioned was new industrial companies
emerging on the wave of innovations. Lower costs were supposed to be passed
onto consumers in the form of falling prices. The resulting expansion of
production would raise wage levels in keeping with productivity, as production
required a parallel growth in consumer demand.

Companies were not supposed to be destroyed
and left as bankrupt shells by financial raiders. Banking was
expected to be modernized to promote industrial capital investment, not loot it
by loading it down with interest charges and financial fees by raiders wielding
junk bonds as their weapon of choice. To supporters and strategists of
industrial capitalism, the driving dynamic was what the Wharton Business School
professor Simon Patten called the “Economy of Abundance.” Innovations in modes
of financial takeovers of industry were more in the character of parasitic
destruction — and few observers anticipated just how creative this destructive
appropriation could become. Or that it would achieve ultimate victory by
attacking and taking over government agencies, the central bank, and Treasury.

Despite the steady rise in productivity,
prices have not fallen and real wages have not increased for the past
generation (since the late 1970s in the United States). Economic gains have
been enjoyed by the FIRE sector, dominated mainly by high finance. Industrial capitalism
has evolved into finance capitalism in ways not dreamed of a century ago. And finance
capitalism itself turns out to be an evolutionary family of offshoots: pension
fund capitalism, the bubble economy, debt deflation, austerity — and the way
today’s trends seem to be leading, perhaps settling into a terminal stage of
debt peonage and neo-feudalism.

What already is clear is that instead of
the promised economy of abundance, economic policy from the United States to
Europe and the post-Soviet countries is now all about austerity. In a bubble economy,
most gains are made not by industrial investment, but by borrowing to buy
assets whose price is being inflated by bank credit. The shift of focus from
industrial profits to debt-leveraged “capital” gains took the form mainly of
land-price gains and higher capitalization multiples for stocks and bonds
reflecting falling interest rates. Real estate spurted for a while, but price
rises reversed after September 2008, leaving a trail of negative equity (when
debts exceed asset valuations). This has dragged down balance sheets for the
banks and insurance companies whose loans and default guarantees went bad.

Foreclosure time has arrived, reducing
debt-strapped populations, “financialized” industrial
companies, cities, states, and entire national governments from Ireland to
Greece to debt peonage. Even the banking sector finds itself in negative
equity. Companies and localities are claiming that they face bankruptcy if they
cannot roll back pensions and even current wage levels and health care
commitments. This is what debt deflation looks like.

Instead of suffering a merely temporary
deviation from an underlying positive growth trend — a “cyclical downturn”
resulting from “illiquidity” — Western economies have entered a fatal phase
change. Debt service exceeds the economic surplus, leading to shrinkage. The
problem is insolvency — an overgrowth of debt, growing autonomously by its own
dynamics (“the miracle of compound interest” plus the banks’ electronic
creation of new credit). Belief that “automatic stabilizers” will correct the
problem is a cover story for deterring public policies to rein in the banks from
their over-lending and speculation. The solution must come from outside the
industrial economy by a debt write-down.

This is how economies normally restored
balance and renewed growth from before 2500 BC to
500 BC, by royal Clean Slates. It is how Solon acted to ban debt bondage in
Athens, paving the way for the democratic take-off, and how Sparta’s kings Agis and Cleomenes later sought to
reverse the financial polarization between creditors and debtors. In Judaism,
the Jubilee Year was what Jesus
announced that he had come to proclaim. In more modern times, Germany’s Economic
Miracle was triggered by the 1947 Allied monetary reform and debt cancellation.

The great economic fiction of our time is
that all debts can be paid — if only countries submit to enough austerity,
impoverish their labor force, close down enough industry, and let banks
foreclose on enough factories — and while they are at it, cut back social
security, health care, and social spending across the board. This is class
warfare waged by finance against the rest of the economy. It is even stifling
the industrial economy, “post-industrializing” it in the West by destroying
domestic consumer markets for output that employees produce.

It is ironic that the left wing of
today’s political spectrum — socialist, Social Democratic and Labour parties — tends to support the financial sector and
its policy of “advance foreclosure” on public debtors (euphemized as
“privatization”). One Marxist tradition blames the financial crisis almost
entirely on the internal dynamics of industrial capitalism — the fight between
labor and its employers over wages and benefits. In this view, capitalists
accumulate industrial profits by not paying labor enough to buy the products it
creates. The industrial sector behaves in a self-destructive way as employers
seek their own immediate gains, not that of the economy at large. Rising wages
are a precondition for raising labor productivity (and hence, for cutting costs),
and poorly paid labor lacks the purchasing power to buy what it produces. Other
critics of industrial capitalism blame the economic crisis on high technology
causing unemployment — and off-shoring production to low-wage countries.

FINANCE CAPITALISM VS. INDUSTRIAL
CAPITALISM

AND THEIR RESPECTIVE MODES OF EXPLOITATION

These are indeed eternal problems between
employers and employees. But today’s labor is exploited increasingly in a
financial way. Corporate raiders empty out their pension funds (or at least,
downsize pension payouts by threatening bankruptcy) and seize Employee Stock- Ownership
Plans (ESOPs), while bankers charge labor directly by personal loans, mortgage loans,
and student loans. The FIRE sector has shifted the tax burden off itself onto
consumers and financialized saving in advance for
Social Security to produce a fiscal surplus that is used to cut taxes on the
wealthy. The corporate sector and the economy at large have been “financialized,” their surplus consumed in the form of debt
service rather than invested in new capital formation to employ labor and
produce more to raise living standards.

What is important to realize is that most
debt in today’s economies is taken on to buy real estate (housing and office
buildings) and financial securities. Within the industrial sector, most
corporate debt taken on for leveraged buyouts, or for “poison pills” as
companies defend themselves against such financial aggression. To focus on the
dynamics of industrial capitalism rather than those of finance capitalism
leaves out of account the fact that banks make loans and create debt (and
deposits) on their computer keyboards. An autonomous financial dynamic is at work,
not merely savings by the industrial sector to be mediated by bankers.

Marx described the industrialists’ hatred
of landlords and the wish from Ricardo through Henry George to
create an industrial circular flow by minimizing land rent. The buildup of property
claims and savings (owed by the economy’s renters and debtors) in the hands of rentiers is the result of industrial capitalism’s failure
to complete its political destiny: freeing economies from post-feudal rentiers. Today’s financial power to set tax policy, make
and enforce the law, and disable public regulation reflects the weakness of
industrial capitalism in the face of the vested interests that have fought back
against the Progressive reform movement since the 1870s.

Industrial
capitalism’s familiar class conflict between employers and wage labor is now being
overwhelmed by financial dynamics. It is appropriate to speak of debt pollution
of the economic environment, turning the economic surplus into debt service for
leveraged buyouts, real estate rents into mortgage interest, personal income
into debt service and late fees, corporate cash flow into payments to hedge
funds and corporate raiders, and the tax surplus into financial bailouts as
banks themselves succumb to the economy’s plunge into over- indebtedness and negative
equity.

The buildup of rentier
wealth derives less from manufacturing than from real estate and monopolies,
and most of all from finance. These rentier drives by
the Finance, Insurance and Real Estate (FIRE) sectors are largely responsible
for post-industrializing the economy. But that does not mean that matters can
be reversed by “manufacturing more once again.” The industrial past cannot be
recovered without winding down the debt overhead, topped by debt-leveraged prices
for housing and commercial real estate, health care, education and pensions.
Yet instead of confronting the financial problem, US
and European leaders blame China. They attribute its success entirely to
manufacturing, not to the mixed public/private economy that has avoided privatization
along financialized lines.

Misinterpretation of the West’s financial
problem and its corollary untaxing of finance, insurance
and real estate — and of China’s success in avoiding this takeover — reflects
the success of rentiers in rejecting classical
political economy’s doctrine of value and price, and its corollary distinction
between earned and unearned income, and productive and unproductive labor.
These concepts are no longer taught. Censorial neoliberal ideology has succeeded
in expunging the history of economic thought from the curriculum and popular discussion.

This self-promotion by rentiers has gouged out a blind spot that is crippling
economic policy today. Forecasting by correlation analysis and regression
equations and kindred statistical model building assumes the status quo as far
as the “environment” of institutional and tax structures is concerned. As
“wealth creation” becomes an increasingly fictitious Enron- style
“mark-to-model” accounting, academic economics likewise becomes more an
exercise in science fiction depicting a kind of parallel universe. There is
method behind its madness. The streamlining of economic theory along the lines
of junk statistics has turned the discipline into bland public relations for
the financial sector.

Classical economics was the political
program of industrial capitalism seeking to free society from the rentier interests. Resisting the classical distinctions
between productive and unproductive investment, credit and employment, the
postclassical economists endorsed by the rentiers
(receiving their charitable largesse as well as the “badge of true science”)
insist that all income and wealth is earned productively. Everyone earns
whatever he or she makes, so there is no unearned wealth. There are no “idle
rich.”

This is the political service performed by
the post-classical Austrian and “neoclassical'’ counter-revolution: denial that rentiers play an unnecessary role. The implication is that Balzac
was simply writing fiction when he quipped (following Proudhon’s “Property is
theft”) that the great family fortunes are grounded in long-forgotten and
suppressed thefts of the public domain and by financial and political insider
dealing. One indeed finds more description of how great fortunes are made from
novelists than from economists. When it comes to wealth and the power elite,
today’s economic models barely scratch the surface.

Today’s austerity is being imposed to
squeeze out more debt service. This requires either the suspension of
democratic government in debt-strapped countries, as in Greece (where Angela
Merkel dissuaded the Prime Minister Papandreou from submitting the European
Central Bank’s austerity plan to a voter referendum), or political distractions
to convince voters to elect neoliberal parties on a platform of ethnic nationalism
or other noneconomic issues, as in Latvia and its Baltic neighbors. As economic
growth gives way to shrinkage (except for public and private debt overhead and
the concentration of property ownership), what seemed to be the long-term trend
of parliamentary reform over the past two centuries is being reversed.

Turning economic theory into a logic
justifying rentier wealth distracts attention from
the widening rake-off of economic rent and financial extraction. The
assumptions made by neoliberal orthodoxy deny in principle that what is
happening can really be occurring at all! The hope is that people look at the
map, not at the territory. It is a false map, turning academic economics into science
fiction about a happy parallel universe where everyone is fairly rewarded and
the world becomes more equal and prosperous. In the real world, “balance sheet
wealth” has become financialized. This means
debt-leveraged — and increasingly post-industrialized. Under industrial capitalism,
profits were made by investing in plant and equipment to employ labor to sell
goods (and a widening array of services) at a markup. Most profits were to be
reinvested in this way, including research and development. And today, retained
earnings continue to be the main source of tangible capital investment — not
bank lending, the stock market, or other external financing.

Two surgeons, Dr. William Petty in Ireland
and Dr. Francois Quesnay in France, used the analogy of the circular flow of
blood in the human body for how national income is circulated between producers
and consumers, employers and employees (known popularly as Say’s Law), and
between the government and the private sector.

The Great Depression saw this circular
flow interrupted. The siphoning off had been occurring ever since feudal times
by rentiers extracting access charges for basic
needs. Keynes blamed the depression on saving and hoarding out of the circular
flow. But the problem today is the diversion of consumer income (wages),
corporate cash flow, and public tax revenues to pay interest and amortization.
This leaves less available for spending on goods and services.

The banks and other financial institutions
and creditors receiving this debt service do not use it to finance tangible
investment. They lend out their revenue to become additional debt claims on the
bottom 99 percent of families, and on corporate industry and governments.

To minimize this diversion of revenue,
industrial capitalism had to confront the vested interests entrenched from
feudal Europe’s epoch of military conquest: a landed aristocracy and banking
families. Paying rent and interest for access to land and credit diverted the
circulation of income between production and consumption. Malthus argued that
landlords spent their rent on coachmen, tailors, and servants. But most
classical economists deemed such spending unproductive because it did not
employ wage labor to produce goods to sell at a profit.

As real estate has become democratized,
buyers can obtain housing and commercial property by borrowing mortgage credit.
The winning buyer is whoever outbids others to pledge the most rent to the bank
as interest in exchange for a loan. The purchase price usually ends up with the
entire rent being pledged — and sometimes the anticipated capital gain as well.
This makes banks the recipients of the ground-rent that was paid to landlords
prior to the 20th century.

Banks also pressed governments to create
commercial privileges and other monopolies. They traded in
government bonds for the infrastructure and trading rights being sold off. To
the extent that these public enterprises were bought largely on credit, their
extraction of monopoly rent, like land rent, ends up being paid out as interest
as these rights are traded and sold.

The symbiosis between banking and
government was the agreement that government bonds would be the foundation of
most bank reserves. Most of this public debt originated as war debt, because
wars traditionally are the major cause of budget deficits. Adam Smith urged
nations to finance wars on a pay-as-you-go basis so that populations would feel
the immediate expense and make an informed choice for peace instead of
burdening economies with war debts owed to financiers. The way to bring prices
in line with the technologically necessary costs of production — and hence to
win export markets — was thus to replace war with peace. Minimizing or taxing
away land rent, monopoly rent and financial charges became the dream of
classical economics as a political reform program.

PENSION FUND
FINANCE CAPITALISM

Finance capitalism took a great leap
forward in the 1950s with the innovation of pension fund capitalism, which
Peter Drucker went so far as to applaud as “pension
fund socialism.” The idea was to set aside part of the wage bill for
professional money managers on Wall Street to invest in the stock and bond
markets. General Motors and other companies described this as giving labor a stake
in industrial capitalism, by turning them capitalist in miniature.

Equities are indeed ownership shares. But
they do not give labor much voice in management, even for workplace conditions
or other employment practices. The situation is similar to that which prompted
minority New York Yankees baseball investor John McMullen to complain: “There
is nothing in life quite so limited as being a limited partner of [managing
partner] George Steinbrenner.” If managers lay off workers or use cash flow for
stock buybacks or higher dividend payout rather than for new direct investment
and hiring, labor is supposed to see itself benefiting as a financial investor.

Pensions could have been organized in a
variety of ways. Public pensions could have been paid out of the general
budget’s progressive income taxation, as in Germany’s pay-as- you-go system. At
the other end of the spectrum, Employee Stock Ownership Plans (ESOPs) gave
workers stock in their employers. These plans ran the danger of being wiped out
in bankruptcy or mergers. This ploy was refined most notoriously in Chile after
1973 under General Pinochet. Recently at the Chicago Tribune, real estate
magnate Sam Zell used the company’s ESOP to pay off his creditors, leaving a
bankrupt shell and an impending set of lawsuits.

None of the above plans gave workers
managerial positions on the corporate boards, as in Germany. Instead
of being spent on the consumer goods that labor was producing, payments to pension
funds were spent on stocks and bonds. What Pinochet (to be echoed by his
admirer Margaret Thatcher
in Britain) would call “labor capitalism” was more accurately “labor finance capitalism.”
Pension contributions were invested in financial markets, pushing up asset
prices. The valuation of wealth rose — real
estate, stocks and bonds — relative to labor’s wages and salaries.

This proved
a boon for managers and venture capitalists exercising their stock options.
These insiders sold, and pension funds
bought. The rising inflow of funding inspired dreams that pensions
could be paid out of capital gains rising exponentially. By the time the
dot-com bubble got underway in the 1990s, a rate of 8 percent compounded
annually was almost universally projected. Any given amount would double every
nine years and quadruple in eighteen to pay much larger future pensions. Soon,
the only way to keep pension plans solvent at given “defined contribution”
rates was for their investments to keep on expanding at this unsustainably high
rate.

The only way to achieve this return even
for a short while was for the Federal Reserve to flood the economy with credit
— that is, with debt. So pension fund finance capitalism became
dependent on the bubble economy orchestrated by Federal Reserve Chairman Alan Greenspan
and continued by his successor, Ben Bemanke, to lower
interest rates steadily down through 2012, capitalizing corporate profits and
real estate rents into bank loans at rising multiples.

According to the rosy textbook pictures,
the stock market is supposed to raise funding for industry.
But stock ownership itself was being decoupled from management, just as the
financial sector was becoming independent of tangible capital formation. As
pension funds became part of the financial sector, they played a major role in
the leveraged buyouts that loaded down companies with junk-bond debt.
Confronted by Michael Milken at Drexel Burnham cheerleading from the 1980s
onward, healthy companies were obliged to defend themselves by taking “poison pills,”
going so deeply into debt so that raiders could not take on any more to buy
them. Some companies used their cash flow and even borrowed to buy up their
stock so as to raise its price by enough to leave less revenue available for
prospective raiders to pay their bankers and bondholders.

FIAT MONEY BASED
ON AMERICA’S MILITARIZED BALANCE-OF-PAYMENTS DEFICIT

To understand what made the bubble
economy’s credit wave possible, it is necessary to understand how the
international financial system was transformed in 1971 when overseas military
spending forced the US dollar off gold. The metal was a pure asset, earned by
running balance-of payments surpluses — and sold off by running trade and
payments deficits. President Nixon’s suspension of gold sales through the
London Gold Pool left the world’s central banks without a means of settling their
balance-of-payments deficits (James Steuart called
gold “the money of the world” in 1767), except to use what had become a proxy
for gold: US Treasury bonds.

These government IOUs were supplied by the
US economy running a balance-of- payments deficit. Ever since the Korean War
broke out in 1950, this deficit stemmed entirely from military spending. US
trade and private-sector investment were in balance,
and what was called “foreign aid” actually generated a payments inflow (being
tied to the purchase of US exports). So the dollars that ended up as global
central bank reserves were the embodiment of America’s military spending (I
describe its dynamics in my 1972 book, Super
Imperialism.)

Removal of gold as an international
constraint meant that the larger the US payments deficit grows, the more
dollars end up in the hands of foreign central banks — which have had little
alternative but to recycle them to the US economy by buying Treasury bonds. The
balance-of-payments deficit thus has become the means of financing the
government’s domestic budget deficit.

The link between the dollarized global
monetary system and military force became explicit after the Organization of
the Petroleum Exporting Countries (OPEC) quadrupled its oil prices in 1973-74
in response to the US quadrupling of grain prices. Treasury officials met with Saudi
Arabian and other OPEC officials and explained that they could charge as much
as they wished for oil (which provided a price umbrella for US oil companies to
make windfall “resource rent” profits), as long as they agreed to hold their
reserves in US Treasury bonds or otherwise recycle their export earnings into
the US economy — by buying stocks, real estate and other property claims, but
not ownership of strategic industries.

US economic strategists soon came to
realize that American investors could buy up foreign assets without limit,
while consumers also imported more. Running up foreign debt created a
proportional inflow of funds to buy Treasury bonds. This reversed the
traditional impact of trade and payments deficits on interest rates. Under the
gold standard, countries running deficits had to raise interest rates to borrow
enough to stabilize their currencies’ exchange rates. But for the US economy,
the larger the payments deficit, the more foreign capital was recycled into US
financial markets. Banks were able to create their own credit electronically without
international constraint.

For the past thousand years the major
factor in balance-of-payments deficits has been military. This often has led to
a loss of economic sovereignty. But under the Treasury-bill standard the US
economy achieved a free lunch. Under the new monetary imperialism, foreign central
banks absorbed the cost of US military spending — and in due course the US
private- sector takeover of their economies.

Monetarily, the US payments deficit had
become inflationary, not deflationary as was the rule for all countries in
times past. However, the inflation was contained entirely within the US
financial and real estate markets. Labor and consumers were not the
beneficiaries.

THE BUBBLE ECONOMY

By 2002, a full-blown financial and real
estate bubble was underway. For the first time in history, people imagined that
the way to get rich was by running into debt, not by staying out of it. As the
Federal Reserve pushed interest rates down, prices for real estate, bonds and stocks
rose — being worth whatever a bank would lend.

The problem for pension funds was that the
falling interest rates that fueled the bubble’s rising “capitalization rates”
of income into bank loans meant lower current returns. This made it more
expensive to buy a retirement income. By 2011, California’s giant pension plan,
CalPERS, was making only a 1.1 percent return. Yet as
noted above, nearly all pension funds since the 1980s have made their projected
ability to pay retirees on the assumption that they can make at least an 8
percent rate of total returns (interest plus dividends) year after year. By the
time interest rates hit their bottom (1 percent), there was no more source of
capital gains from higher bank liquidity lowering them further.

Pension funds tried to catch up by
speculating in financial derivatives that had no counterpart in tangible
investment or employment. To make matters worse, financial fraud was effectively
decriminalized as the Justice Department, Securities and Exchange Commission,
and other regulatory agencies refused to prosecute. Fraud became part of the
“free market.”

Regulatory agencies were understaffed, and
administrators were chosen who were committed to not enforcing the rules. Many
appointees reaped their rewards for inaction by what the Japanese called
“descent from heaven.” They received enormously well paying jobs when they left
these agencies to join the sectors they had been charged with regulating.
Politicians made eloquent calls for new laws — while refraining from using
those already on the books that had long been used.

Banks and pension funds lent mainly to
other financial institutions, not to finance new capital formation or
employment. The new era of asset-price inflation had changed the economic aim —
in fact, the foundation of economic solvency — to making capital gains by debt leveraging.
By 2008, the bubble dynamic burned out in what Hyman Minsky
called the Ponzi stage of the financial cycle.
Investors and speculators paid their backers by borrowing the interest — and
even borrowing the hoped-for price gains for real estate, stocks, and bonds. Companies bid up prices for their own
stock by using cash flow and even by borrowing — while increasing earnings by
outsourcing production and downsizing employment.

Tax policy also favored making capital
gains rather than earning wages, salaries, or profits. And the Federal Reserve
was able to inflate asset prices by flooding the economy with enough credit to
lower interest rates, enabling banks to capitalize a rental or corporate income
at a higher multiple in lending to new buyers. What President George W. Bush
euphemized as “the ownership society” was becoming an increasingly
debt-leveraged economy. Raising home ownership rates for racial and ethnic
minorities (and for low-income families in general) were achieved by loading
them down heavily with debt at exploding “adjustable” mortgage rates.

Alan Greenspan urged homeowners who chose
to stay in their property to “cash out” on their home equity by borrowing and
spending the loan proceeds as if it were income. As wages and salaries had
stagnated since the late 1970s while medical costs and other prices rose, such borrowing
more against one’s home became the only way of maintaining living standards for
many families. The Protestant Ethic of living off interest, not eating into
capital or going into debt, was becoming obsolete. Debt leveraging was
applauded as the way to get rich.

But
this created a policy quandary once the process had run its course by lowering interest
rates and easing credit terms. If governments let interest rates rise again,
this would cause losses in the capitalized value of real estate rents,
corporate earnings, stocks, and bonds. So central banks were locked into low
interest rates, such as the Federal Reserve’s Quantitative Easing policy in
2010 and 2011.

This turned the dream of pension fund
capitalism into a nightmare of insolvency. Financializing
pensions by steering revenue into the financial markets to build up claims on the
economy had an opposite effect from direct investment to earn revenue on a
current basis. Pension funding helped bid up prices for
financial assets while interest rates were falling. But when the bubble had run
its course the economy was left loaded down with debt. Its carrying charges
blocked recovery by diverting spending away from markets for goods and
services.

DEBT DEFLATION IN
THE POST-BUBBLE ECONOMY

Paying
down debts raises the reported rate of saving, because the negation of a
negation (lower debt) is counted as a positive (saving). This is the form that
saving is taking in the US economy today: reducing credit card balances and
paying down mortgages, student loan balances, and other obligations. This is
not a buildup of funds available for spending. Most people have less to spend
as they pay debt service. And they are less able to borrow as banks are pulling
back their credit lines, seeing the economy become more risky and hence less
creditworthy.

Economies shrink when debt service diverts
spending away from consumption and investment. And as economies shrink,
financial risks rise. Companies cannot borrow by issuing their own commercial
paper IOUs, because the wave of deregulation has destroyed the trust needed for
financial markets to work. And banks are not relending their inflow of loan
paybacks to the “real” economy, but entirely to other financial institutions;
or, they are rebuilding their reserves of government securities, or speculating
on arbitrage gambles.

Credit has dried up even more drastically
in Europe. An obsession with government budget deficits prevents them from
supplying the economy with spending power. Decades of bank propaganda have
implanted a false memory in Germany’s population. The Weimar hyperinflation in
the early 1920s is blamed on the Reichsbank financing
a domestic budget deficit. What actually happened is that the central bank
tried to meet Germany’s unpayably high reparations by
printing reichsmarks
and desperately selling them on the foreign exchange market to raise the hard
currency being demanded by the Allies. The problem was not domestic money
creation to finance German spending, but war debts denominated in foreign currency.

Bankers
have crafted a narrative that has drowned out memory of what actually happened
in history — and also misrepresented how central banks are supposed to work in practice.
In a bold attempt to deter today’s governments from having their own central
banks monetize their deficits, bank lobbyists and their pet academics parrot
the absurd falsehood ad nauseum that central bank financing of budget deficits
is inherently inflationary — indeed, hyperinflationary, likely to bring on
economic collapse. The only “stable” policy, bankers insist, is for governments
to borrow from them — as if they are “honest brokers” wisely lending only for
economically viable productive purposes.

Even a cursory look at recent US and
British experience should dispel the idea that central bank money creation must
inflate commodity prices. The Bank of England and the Federal Reserve do what
central banks were founded to do: monetize public budget deficits. This is what is needed to save economies
from plunging into depression today — although, in fact, the deficits have
stemmed from bailing out the banks and financial sector. Since 2006, the
Federal Reserve has overseen the largest new money creation in history. Yet
consumer prices and wages barely rose. Likewise in Britain, the pound has held
steady, as has the dollar.

What has occurred is a debt-leveraged real
estate bubble collapsing into negative equity. Yet Europe remains committed to
austerity, pushing its economies deeper into depression. Latvia and Greece limp
along as object lessons to show how financial and fiscal austerity leads to
plunging employment, bankruptcies, collapsing property prices, and foreclosures.
Labor is unable to find work and emigrates. So debts end in default and
national budget deficits worsen.

Even as economies are being driven into
debt deflation and depression, the “Troika” of EU leadership, the European
Central Bank (ECB) and International Monetary Fund (IMF) are calling for
balanced budgets instead of public spending to revive employment. Neoliberal ideology
holds such spending responsible for the inability to pay creditors. It demands
that governments pay by raising taxes on the nonfinancial sector — for bad
private- sector debts as well as public debts.

Ignoring the problems caused by private-sector
debt and bad bank lending frees the banks from blame, as if their lending were
not the main cause of raising prices for houses and other assets. It adds
injury to insult by demanding a “solution” that gives the banks a windfall.
Neoliberals seek to use the financial
crisis as an opportunity to push a grab bag of benefits. For starters, they
urge that progressive taxation be abandoned in favor of a flat tax, excluding
capital gains and other rentier income. The policy is
to be capped by selling off public assets to bank customers. So banks are to be
given even more subsidies to keep them afloat under their own bad-debt burden
that has wiped out their reserves. These solutions would impose fiscal
deflation on top of debt deflation.

Misrepresenting the debt problem as a
demographic one, financial lobbyists point out that people are living longer.
They then claim that governments cannot balance their budgets without slashing
Social Security, just as the private sector has been downscaling defined benefit
pension plans into amorphous “defined contribution” plans. (Wages are withheld
in the hope that Wall Street money managers will make capital gains.) In this
reading, the “solution” to the economy’s debt overhang is not to write down
debts, nor to restore progressive taxation and pay Social Security, health
care, and other public spending out of the general budget. The social safety
net is to be scaled back so as to reduce taxes and become more “competitive.”

THE BAILOUT
ECONOMY

In the single case where government
budget deficits are urged to increase — indeed, soar to veritable wartime
levels — the purpose is not to revive economies, but to bail out banks for the losses
suffered from lending out more than realistically can be repaid. Bad bank loans
are to be shifted onto the public balance sheet. If the central bank is blocked
from monetizing the cost by buying government bonds and thereby putting money
into the economy (something that current EU policy and the German constitution
forbids the ECB from doing), then taxes will have to be raised or public
spending cut back drastically (as in Ireland since 2010).

This anti-industrial, anti-labor policy
rules out writing down debts to what can be paid under normal conditions — that
is, paid without widespread forfeiture of property. Wealth is to be siphoned
off to the top of the economic pyramid.

Someone must lose, of course — and the
motto is “Big fish eat little fish,” mediated by the government in today’s financialized travesty of a “free market.” Most fortunes in
history have come from the public domain, after all. The first aim is to take
government funding and bailouts and run. The second is to deter prosecution by
turning campaign contributions into the right to name (or at least veto) the
leading public administrators. For example Sheila Bair, head of the Federal
Deposit Insurance Corp. (FDIC), argued that Citibank could have been permitted to
go under without disturbing its basic consumer-banking operations. Known for
“stretching the legal envelope,” the bank had sufficient assets to back its
insured deposits. What would have been wiped out was the financial web of cross
claims and gambles among large institutions. Instead, Treasury Secretaries Hank
Paulson and Tim Geithner gave Citigroup $45 billion.

They also bailed out the insurance and
casino capitalist conglomerate AIG. It could have preserved its “vanilla”
retail and business insurance operations, merely defaulting on its insurance
contracts its London office had written for junk mortgages that ratings
agencies marked AAA prime. The economy- wide tangle of collateralized debt
obligations, cross default swaps and other “toxic waste” could have been wiped
out, putting the “real” economy first. But the government paid AIG’s counterparties $182 billion in 2008, followed by more
giveaways.

A financial “free market” meant that
ratings were up for sale, much as Enron-style accounting had corrupted Arthur
Andersen. No large Wall Street institution received a single criminal charge or
prosecution. Exorbitant financial bonuses and salaries hardly missed a beat while
home foreclosures soared for the economy at large. The financial “fat” was
saved even at the cost of destroying the industrial “bone.” Interlocking
conflicts of interest and non-enforcement of rules preserved the financial
parasite at the cost of weakening the industrial host economy. Debts by honest
home borrowers were left in place, but debts owed by defaulting financial
insiders for bad gambles on which way prices, interest rates, and foreign currencies
would move were paid to the winning bettors.

A similar financial favoritism occurs by
permitting financial managers to threaten corporate bankruptcy to wipe out
pension plans and health obligations. Contractual obligations to employees have
been shifted (and downsized) onto the underfunded Public Benefit Guarantee
Corp. (PBGC). The “sanctity of contracts” has become one-way, annulling obligations
owed to labor. This is said to be a free market, but reflects the financialized takeover of the public sector.

THE AGE OF JUNK
ECONOMICS

Classical economists set out to free
Europe from its post-feudal legacy of rentier claims,
and to define the surplus being siphoned off to pay a hereditary landlord class
and bankers. But the rentiers mounted a
counter-reform effort. Recognizing that voter preferences and public policy are
shaped by perceptions of how the world operates, rentiers
sponsored an effort to turn economic thought into science fiction describing a
parallel universe. Switching attention away from empirical reality to “a
science based on assumptions” takes the form of defining the task of economic
“science” as being to provide a logic demonstrating that economies
automatically regulate themselves. Attempts to restore a balanced
public/private economy with regulatory checks and balances are defined as
adding to the cost of doing business, ipso facto. The resulting tunnel vision
dulls the mind from sensing the danger posed by the financial takeover.
Economic theory is turned into an anti-labor, anti-government, and
anti-regulatory exercise in public relations lobbying.

This inverts the idea of what the word
“scientific” means. Neoliberal ideology deems it scientific to restrict
analysis, theory, and model building to how economies would work without any government
policies. Such policies cannot be “universal” in the same sense as the laws of
physics and chemistry. Tax laws, government spending programs, and other
institutions differ for every country, giving much leeway for choice.
Emphasizing abstract universals excludes at the outset what should be the
object of political economy: national policy and changes in the institutional
and fiscal framework.

The resulting orthodoxy describes how a
hypothetical economy would work if it had no real
central bank, if it privatized basic infrastructure and offered its services at
cost (including normal
profits) despite deregulation of price controls and abolishing anti-monopoly regulations,
and if it does away with consumer protection and anti-fraud statutes. Monopoly power
is called “free competition” as long as stocks in monopolies can be bought and
sold by anyone, domestic and foreign alike. More specifically, the kind of
“scientific” mathematics being employed limits its variables to wage levels,
government deficits, and consumer prices, so as to endorse a race to the bottom
— and indeed, to imply that “there is no alternative” (TINA). In practical
terms, this mathematical “garbage in, garbage out” (GIGO) exercise means no
hope for change in the status quo, no hope for countries falling into debt
except to accept their dependency on their creditors.

In contrast to the natural sciences that
start with empirical reality, neoliberal economics starts with fiction and
reasons deductively from a set of carefully selected assumptions designed to
prove that public investment and other spending is wasteful, regulation and
forward planning are burdensome and ineffectual. The inevitable conclusion,
reached purely deductively, is that bankers should be left to decide how to
allocate the economy’s resources.

This logic begins by choosing assumptions
that will lead to the conclusion being sponsored, and working backward. The
cooked conclusion is that economies get rich by cutting social spending
(defined as an “interference with the free market”), dismantling government regulations
(except for the central bank, which is to be controlled “independently” by the
financial sector and given veto power over all other public agencies), and
charging user fees for education, health care, and other public services. Wages
are to be lowered in order to increase competitive export power to earn the
money to pay creditors, on the assumption that this will not reduce labor productivity.

Banks are to act as the economy’s
planners, as if this is not more centralized than planning by elected
officials. Public office itself is to be made part of the “free market” by permitting
campaign contributions by Wall Street and other business lobbyists without
limit to buy TV and media time, and endow public relations “think tanks” to
shape voter opinion, along with business schools to craft a body of airy
mathematics purporting to demonstrate that neoliberal counter-reforms are
efficient. Lenin may not actually have coined the term often attributed to him
to describe such people, “useful idiots,” but the phrase certainly is apt.

This is the logic that rationalizes
privatizing land rent and public monopolies on credit instead of taxing or
socializing their ownership privileges. Banks, mineral resource ownership, basic
infrastructure, and monopolies have been organized into corporations selling
shares. They have become the new “land barons.”
Their claims for economic rent and financial returns
can be passed down to the heirs of whoever buys them. So rentier
income is still being concentrated at the top of the economic pyramid, albeit
in the hands of a post-feudal creditor class. The new mode of conquest is
financial, no longer overtly military. Unless, of course, countries
resist being “financialized.”In such cases they are isolated by sanctions,
Cuba- or Iran-
style.

The trick is to distract attention from
how debt deflation shrinks economies and dries up new investment and
employment. And when resources really become scarce, economists call it a
crisis. This usually is the point where they agree that the time has come to
suspend democracy and bring in the “technocrats” (a euphemism for bank
lobbyists), as they did in Greece and Italy in 2012.

All this has reversed the direction in
which Western civilization was moving until World War I. Economies are
retrogressing toward pre-Enlightenment rentier
societies. The classical ideal of regulating prices in line with cost-value is
now denounced as an exercise in bad “statist” economics. It is as if the past
three or four centuries have been a great mistake — what Frederick Hayek called
a road to serfdom, not away from it by limiting rentier
power.

This reaction turns the idea of free
markets into the opposite of what classical economists meant — a market free of
unearned income. Prices and incomes were to be brought in line with cost-value.
The “unearned increment” was supposed to be taxed away: land-price gains
(ground-rent), mineral rents (provided by nature and rightly treated as
national patrimony), and what manmade monopolies charged over and above normal
profit rates for providing their services. Governments would invest the tax
revenue from economic rent in infrastructure providing basic transportation,
communication, and other services at subsidized prices, and ultimately freely,
just as already was being done for roads, public education, and health.

As governments provided a widening range
of infrastructure services, industrial capitalism in the classical economic
vision was expected to evolve into socialism. In Britain, Prime Minister
Benjamin Disraeli’s social welfare legislation was capped by the public health system
introduced from 1874 to 1881 and promoted under his motto Sanitassanitatum, “Health, all is health.” This
helped the Conservative Party evolve as a nationalist, sometimes “state socialist”
party, especially after World War II under Harold Macmillan in the 1960s. In Germany,
Bismarck enacted a pension plan for the population at large, not just army
members as in times past.

By contrast, today’s financial interests
use the mathematical language of physical scientists to pretend that austerity
will cure the government’s budget deficit and balance of payments. The reality
is that a shrinking economy is less able to pay taxes and debts. Upon any truly
empirical scientific examination, neoliberal logic is a public relations tactic
in today’s financial war against society at large. The aim is to lock in power
the way Rome did: by reducing as much of the population as possible to debt
dependency.

And just as in Rome, today’s debt
overhead cannot be paid. The question is, just how will it not be paid? Will
society realize the need for debt write-downs, or will it permit massive
foreclosure to tear society apart and reduce debtors to neo-serfdom?

Today’s bankers explain that debt crises
should be solved by yet more lending, as if this will “get economies moving
gain.” It is as if economies could borrow their way out of debt. If we are
indeed to take Germany’s hyperinflation as paradigmatic, as bankers argue, we
must recognize that the mark was stabilized in the same way France had paid
after the Franco-Prussian war ended in 1871: by borrowing. German states and
cities borrowed dollars in New York, and converted them into marks that the Reichsbank printed. It then used these dollars to pay the Allies — who
turned around and paid them back to the United States for their arms debts stemming
from World War I. The illusion of stability was achieved simply by running up private-sector
debt (to US bondholders) to replace intergovernmental arms debts and
reparations. This was just the opposite of today’s European and US taking bad
commercial bank debts onto the public balance sheet.

In 1931, the pretense finally was ended
by a moratorium. This must be how today’s debt overhead also must end because
debts that can’t be paid won’t be. Trying to prolong the day of reckoning will
only impose an interregnum of austerity during which the financial sector will
extract as much revenue as it can get away with, and foreclose on as much
property as society will permit. Making itself a new
ruling elite to lord it over what remains of the 21st century. Wall Street’s
conquest promises to join Spain’s conquest of the New World and the Nordic
conquests of Europe — and is in much the same spirit as Rome’s conquest of its
Empire two thousand years ago. The results for society at large threaten to be
equally devastating today.

FROM DEBT PEONAGE
TO NEOFEUDALISM

Today’s finance capitalism is more
impersonal than the Viking conquests that parceled out Europe’s land among the
conquerors. In due course the land, natural resources, and monopolies that
feudalism privatized were sold to banking families that lent money to fight for
more property and trading rights. Appropriating and expropriating resources is
now an autonomous financial dynamic, working more covertly and even in a more
democratic political context than military conquest. An almost impersonal array
of banking institutions replaces seizure by force of arms.

Unlike serfs, debt peons are free to live
wherever they wish — or at least wherever they can afford. They may buy land by
taking out a mortgage and paying its rental value to the bank. But wherever
they live they take their debts with them, from student loans to credit card
debt.

Also unlike military warfare, financial
conquest does not kill people directly. It is much more genteel. Debt deflation
causes poverty, discourages family formation, marriage and birth rates, and
shortens lifespans. This prompted Vladimir Putin to
note that neoliberal policies and privatization along kleptocratic
lines had destroyed more of Russia’s population since 1990 than the nation had
lost in World War II. Instead of the “Seven Boyers,”
Russia had its “Seven Bankers” after Boris Yeltsin’s 1994 loans-for-shares
privatization of the nation’s most valuable natural resources and monopolies.

Rome’s creditor-oriented economy
collapsed into the Dark Age, plunging the Empire into
debt peonage. It became the first major society not to cancel its debts.
Predatory legal and political systems drive populations into debt, yet may
survive longer than mathematical models would expect, despite infrastructure
falling apart and employment drying up. It took from the first century BC’s
Social War (133-29 BC) to the fourth century AD turning point for economic life
to decentralized and revert to self-sufficient landed
estates.

Today a similar problem of debt deflation
is polarizing society and imposing austerity, drying up the internal market.
The dream of bank marketing departments, after all, is for all disposable
income (over and above spending on basic needs, to be kept to the minimum) and corporate
cash flow to be paid as debt service. During the upswing of debt, this was
called “treating your home like a piggy bank” by taking out an equity loan. But
that was not a fair analogy. Buying a home has become a means to drive
populations into debt. And now the debts remain in place, leaving
the banks with the power — which they have used to buy control of governments.

Unless the world changes its path, the
“final” stage of finance capitalism threatens to deteriorate
into debt peonage so widespread as to become neo-feudalism,
relinquishing control of the economic surplus to a financial elite making
itself as hereditary as the old landed aristocracies.

IT DOESN’T HAVE TO
BE THIS WAY

In addition to the moral fairness of
bringing prices in line with cost-value so as to free society from special
privileges that create “unearned” rentier income
without work, classical economics was a guide to making societies more
productive and efficient. Governments seeking to nurture their national industry
saw it as a strategy for how to modernize. So the same logic that evolved into socialism
via Saint-Simon, Marx and other reformers provided the model for the industrial
classes to make France, Germany, and other economies more competitive so as to
overtake Britain in the 19th century.

As noted above, the thrust of classical
political economy was to free society from rentier charges
that simply added “empty” pricing to the cost of living and doing business:
land rent, monopoly rent, and financial charges. The major beneficiaries of
reforms designed to minimize these economic rents were industry and labor.
Pro-labor reformers characterized themselves socialists,
and pro-industrial reformers often have been characterized as “state
socialists.”Despite
their opposing class interests in terms of employer-employee relations, they
shared a common interest in freeing society from the heavy overhead rents
extracted by landlords, monopolists, and the financial sector.

These special rentier
interests sought to remain free of rent taxes and price regulations. To them, a
“free market” was one that was free for their unearned income to remain free
from public taxation. This led them to oppose government power, at a time when
democratic politics was aligned against them and was minimizing the ability of
the House of Lords in Britain and upper houses in other nations from blocking
progressive taxation and its associated classical policies.

The classical program of free markets —
that is, markets free from prices in excess of cost-value — was to tax land
rent (or at an extreme, nationalize it), and to keep basic infrastructure and natural
monopolies in the public domain so as to provide basic services at cost or at
subsidized rates. This meant a mixed economy, not only a one-sided private
sector. An active public sector was to absorb the cost of infrastructure,
education, health care, and pensions — mainly by taxing the rental value of
land and natural resources.

One of the most systematic defenses of
this policy was voiced by Patten, mentioned above as the first professor of
economics at the Wharton School of Business at the University of Pennsylvania
from the 1880s up to World War I. He described public infrastructure as a
“fourth factor of production,” whose return was measured not by the profits and
price markup it made, but by its ability to lower the national price structure.
This was the strategy that guided industrial development in the United States,
Germany, France, and Japan. These and other nations provided a widening array
of basic infrastructure services at subsidized rates, and indeed free of
charge, e.g., roads, education, and so forth. Likewise, public money creation —
most notably America’s greenbacks issued during its Civil War — would save
taxpayers from having to pay bondholders. Patten’s term “Economy of Abundance”
held out hope for an overlap (or at least an olive branch) between industrial
“state socialism” and labor socialism. Both lines of development were based on
value, price, and rent theory applied on a national level in a mixed public/private
economy.

In the monetary sphere the thrust of
this movement was more diverse but centered on replacing interest-bearing debt
with equity profit-sharing arrangements, and on public money creation replacing
private bank credit. Lending was to be productive. In the sphere of public debt,
the way to minimize an economy’s fiscal overhead was to refrain from wars.
Since the time of Adam Smith, the logic of free market reform was one of peace.
The rivalry that was envisioned was commercial, between old-style rentier economies and reformed “statist” economies.

When World War I broke out, there was
widespread belief that complex industrial economies could not afford war. Many
economists forecast that the Great War would have to end in just a few months
as countries ran out of money. But governments soon discovered that central
banks could create much more money than was anticipated. As the United States
had shown in its own Civil War half a century earlier, it was not necessary to
tax or to borrow.

The implication was that an all-powerful
commercial banking class was no more necessary than a dominant landlord class.
Taxes were not necessary so much to finance government as to tax unearned
income to preserve a fair society and prevent vested special interests from
developing. This is the thrust of Modem Monetary
Theory (MMT), centered at the University of Missouri-Kansas City and allied
schools. This line of analysis was not pressed by the victorious Allies, nor was
it retained in Germany. By the 1920s, an alternative to the classical economic
reform program was being crafted by the rentiers.

In fact, by the time America succeeded
in surpassing Britain as an industrial power, it had little interest in
promoting its protectionist public investment policies in other countries. Its strategists
wanted to “pull up the ladder.” By the 1980s, the classical economic reform
program had become consigned to the realm of unhistory,
excluded from the academic curriculum.

The new idea of
competition was based on privatizing infrastructure on credit, just as real estate
ownership rights were sold. The definition of good management was to create
rent-seeking opportunities — financed by interest-bearing debt. Education,
health care, and medicine were to become privatized as rent-extracting
opportunities. Pensions were to be financed by saving in advance and living off
the interest or capital gains achieved financially, not necessarily industrially.

If this “future” had been forecast a
century ago, most economic observers would have found it so unlikely as to be
unbelievable. Their first question would have been how an economic system can
win if it is made high-cost rather than low-cost? Would not basic competitive
forces bring about a world free of rentiers , a peaceful world with less class warfare between these
old post-feudal classes and the “real” economy of industry, production, and consumption?

No major economic writer expected the rentier classes to fight back with any great success beyond
protesting that taking away their privileges was akin to communist
dictatorship. And indeed, who would have thought that libertarian or “Austrian”
ideas of a stateless economy (dominated by rentiers,
headed by bankers) would spread beyond navel-gazing academics living in an “as
if’ world? Governments were moving toward progressive income taxation,
investing in infrastructure, and establishing public banking and monetary
systems.

But the counter-reform movement has
convinced many voters and public officials that there is indeed no alternative.
To make sure that this will be the case, history is being rewritten, above all
that of economic thought. Pro-rentier lobbyists
recognize that to impose their travesty of free markets, they need totalitarian
control of the academic discussion, censorial power over the press, and
ultimately the threat of violence. This is what the Chicago Boys realized in Pinochet’s Chile with their 1973 dress rehearsal for
neoliberal policy. Their first act was to close down every economics department
in the country, and inaugurate a Latin American assassination campaign,
Operation Condor. This is the Inquisitional side of free-market economics.

Today’s creditor interests are pursuing
much the same road to feudalism that Rome followed two thousand years ago when
its oligarchy initiated a century-long Social War (133-29 BC) by political
assassination and widespread violence. This was by no means an exercise in creative
destruction. It ended up indebting the citizenry and left imperial looting
(“spreading peace”) as the last available gain-seeking opportunity in a
shrinking economy.

THE MAIN SOURCE OF
ECONOMIC IMBALANCE AND POLARIZATION, AND

POLICIES TO COPE
WITH IT

Credit — and hence debt — obviously has
been needed since a specialization of labor developed with the seasonal rhythms
and gaps between planting and harvesting in the Neolithic agricultural cycle.
It is implicit wherever there is a time gap between initial investment and the final
product being delivered and paid for. Interest is first documented in the third
millennium BC as a way for Sumerian public institutions to estimate their fair
share of their gains on commercial advances to traveling merchants.

Most agrarian debts were also owed to
royal collectors, mainly for land rental fees, water and shipping, and consumer
loans. When this “barley debt” overhead grew too large, early Near Eastern rulers
restored order with Clean Slates annulling these unpaid charges. Rulers were
under no illusion that their economies automatically would settle in economic
and financial balance. Instability was inevitable from natural
disasters and wartime disruption, and simply from interest accruals increasing
the debt balances quickly beyond what debtors in low-surplus economies could pay.

Administrators were not so idealistic or utopian as to attempt to design a system
that somehow would not get out of balance. The archaic approach was to deal
with the inevitable insolvency when it became necessary to annul consumer
debts. The fact that most debts were owed to palace and temple collectors meant
that the authorities were basically cancelling debts owed to themselves.
(Commercial silver debts for productive loans among merchants were left in
place.)

These Clean Slates restored order in
times of natural disaster or emergencies, and also when new rulers took their
first full year on the throne. The aim was to inaugurate their reign with the
economy in balance, by clearing away the accumulation of unpaid obligations
that had built up as a result of an inability to pay.

Realization that there is no inherent
tendency toward equilibrium (much less an equitable balance) is missing from
today’s theorizing. Equilibrium mathematics based on diminishing returns and
marginal utility (while ignoring compound interest and its growing debt burden)
is irrelevant at best, and at worst a deliberately engineered distraction. When
we see unrealistic economics built on false assumptions maintained in the face
of repeated failure, we must look for special interests as the beneficiaries.

So just as
industrial engineering has given way to financial engineering, rentier lobbying has given way to ideological engineering
to shape perceptions of what is happening — because the diagnosis determines
the policy cure. As economies veer out of balance and polarize, rentiers aim to deter economies from doing anything to
prevent this widening imbalance. They pretend that “automatic stabilizers” will
restore normalcy. But no such stabilizers are strong enough to rectify
financial imbalance and predatory behavior. Antiquity was able to avoid polarization
for many thousands of years precisely because it was free of such preconceptions.

These are only a century old, promoted
by the anti-classical reaction against Progressive Era reforms. In behavioral
terms, today’s targeted dulling of perceptions that something is drastically wrong
with the economy’s health is similar to what parasites do in biological nature:
They numb the host’s ability to perceive that a free rider has taken over. The
economic equivalent is Milton Friedman’s popularization of the science fiction
writer Robert Heinlein’s motto, “There is no such thing as a free lunch.” What
better way is there to deter the study of just how much of the economy is
indeed a free lunch (economic rent), who gets it, and who is being exploited?

Parasites love
deregulation — as the financial sector loves “free markets.” There is no
room for the study of economic rent in the marginal utility approach to pricing
or the Austrian economics sponsored to replace classical value theory. Denying
that there is any such thing as unearned income or wealth, the new ideology
seeks to erase the contrast between fair and equitable pricing and taxation as
compared to exploitative rent extraction or, for that matter, the outright
fraud that has become almost part and parcel of today’s financial sector.

Biological parasites trick the host
into believing that they are part of its own body, even to be nurtured as if
they were its offspring. But what actually is being reproduced is the parasite’s
own life cycle. The economic equivalent of this favoritism for the free luncher occurs when interest is made tax deductible so that
the financial sector can obtain more revenue to nourish its growth at the
expense of the nonfinancial host economy. It occurs also when the Treasury
favors debt over equity financing, and taxes financial gains from asset-price
inflation and speculation (“carried interest”) at only a fraction of the rate
levied on earnings from tangible capital formation, wages, and salaries.

In biological nature a smart parasite
will keep the host alive and even help it find new sources
of food, and perhaps keep it disease-free in a symbiotic relationship. The aim,
of course, is to obtain most of the nourishment for itself and its offspring,
over and above the basic subsistence level needed to keep the host alive.

But parasites shorten their time frame
as they approach the end stage of the relationship with their host. Realizing
that the game is nearly up, the free luncher does the
equivalent of taking the money and running. It may encourage its host to act
recklessly and be eaten by its own natural predator. A parasitized insect, for
example, may lower its defenses and be eaten by a bird, which will become the
new host for the parasite’s eggs to hatch within it. The parasite’s progeny
will start a new life, higher in the food chain where the numbed and value-free
host has ended up being “globalized.”

Alternatively, the parasite lays its
eggs in the host directly, to hatch and devour its body as their food supply.
This is essentially what occurs when the inexorable mathematics of compound interest
absorbs the “real” economy’s profits, disposable personal income, and tax
revenue. Since economies were stricken in September 2008, the financial sector
has adopted a hit-and-run business plan, using its control of the host
economy’s brain (government agencies, above all the Treasury and Federal
Reserve) to give it bailouts, and threatening to paralyze the host economy by stopping
its circulation of payments if it does not get its way.

Today’s financial free riders are
abandoning ship to enter into a new symbiosis with new host economies. By the
time the Federal Reserve gave the banks 800 billion dollars in QE2 in 2012,
most was spent in the BRIC countries and other healthy targets via exchange
rate and interest rate arbitrage. The financial game plan is to numb the
defense mechanisms of China and other less financialized
countries the way neoliberals did to Russia in the 1990s.

What will happen to the host
economies left as emptied out shells? Will the Untied States and Europe simply
be left nearly for dead, having been turned into zombies by being financialized?

Today’s industrial host economies stand
at a crossroads over this problem. To survive, they need to reverse the
disabling of their regulatory defense mechanisms. The first step must be to
revive classical political economy’s distinction between cost-value and price.
The labor theory of value was an analytical tool to isolate economic rent as
the element of price that has no necessary cost of production — “unearned
income” because it has no counterpart necessary cost of production.

To bring prices in line with
cost-value called for a revolution against feudal privileges in Europe and the
regions it colonized. On the eve of World War I, the reform program seemed to be
succeeding. But it was rolled back when the “real” host economy had its
analytic perception and regulatory warning organs disabled.

Suppose the host economy wakes up and
senses what is going on. How is it to translate this perception into action in
the political, law-making, and fiscal sphere?

In Europe, Parliamentary reform was
expected to be the political catalyst, assuming that voters would act in their
enlightened self-interest. Britain cleaned up its “rotten boroughs” in the 19th
century, and the constitutional crisis of 1910 was resolved by an agreement
that the House of Lords could never again block a House of Commons revenue
bill. The way was freed for reformers to tax unearned land rent.

However, rentier
- backed demagogues have relegated the classical emphasis on the fiscal and
monetary dimension of political economy to merely a secondary position.
Elections are fought over ethnic rivalries (in the Baltics
and the American South), conservative horror at the thought of legalizing
women’s rights and sexual equality (in right-wing religious areas and white collar
urban precincts), or “democracy” (in US protectorates abroad, where the term
has become synonymous with pro-US regimes rather than reflecting any particular
political system). This calls into question the optimistic Enlightenment
political premises of full knowledge of what is happening and enlightened
self-interest as a guide for action.

If most voters are to act in their
self-interest, this requires a revival of the logic that underlay the
Progressive Era’s reform program. It must start by re-establishing the
grounding of 19th century discussion in value, price and rent theory, the tax
policy that follows from it, and monetary theory as it applies to financing
public budget deficits.

Chicago School censors exclude such
discussion from the journals and the curriculum where they hold sway — not
always at gunpoint as in Chile, but more simply by controlling young
professors’ access to tenure-track positions under “publish or perish” in
journals fallen prey to rentier intellectual numbing
and blind spots.

The result may seem ironic, because it
has left the critique of pro-rentier markets “free” from
public regulation and investment, and from progressive taxation, and predatory
finance has been left mainly to Marxists. The explanation is that, as Patten
pointed out, classical economics culminated in Marx (and in Henry George’s advocacy
of taxing land rent). Marx and the socialists simply pushed the classical
analysis to its logical conclusion in using the labor theory of value to
isolate economic rent as unearned and hence unnecessary income — and applying
this concept to banking and finance (which Ricardo never did!) as well as to
land ownership and monopolies.

The classical focus on freeing markets
from technologically and socially unnecessary overhead charges frightened high
finance and its rentier clients, inspiring them to
back an anti- classical reaction. Economic theory and ideology remain
traumatized by this conflict between these rentier
interests and those of industrial capital and labor. This trauma has become
political, and is now challenging the core of how Western civilization has
defined its post-feudal identity since the Enlightenment.

The underlying conflict between
creditors and debtors has happened ever since antiquity succumbed to the
post-Roman Dark Age. A negative equity economy is one that is losing blood — in
economic terms, the circulation of income is drained to pay debt service. And
the financial sector that receives this revenue behaves much as rats jumping ship
or parasites steering their host to be devoured, or simply devouring them
directly from the inside.

This is the state in which today’s
debt-ridden economies are suffering, from Iceland and Latvia to Greece and
Ireland. The deadly demographic effects are emigration, falling family formation
and birthrates, shortening lifespans, and rising
suicide rates.

This is not a natural death process. Yet
the financial sector blames it on demographic aging.
It blames budget deficits not on cutting taxes on real estate, finance and
other wealth, but on the elderly for trying to enforce payment of the Social
Security and pensions they were promised and for which they pre-saved in their
wage agreements. Yet the productivity gains since World War II — or indeed,
since 1980 — have been large enough to support these payments and, for that
matter, the leisure economy that was promised.

The problem is financial disease. It
gained its initial foothold by crippling the guiding hand of government’s
forward planning and regulatory mechanisms, and replacing progressive taxation
and rent collection with favoritism over industry and labor. So the fight is
not really a demographic one between the elderly and the “working population.”
It is between employed labor and retirees together vis-a-visan extractive financial elite allied with real estate
and monopolies.

The fight is being waged over who will
control government, its tax, and its regulatory system. In the political
sphere, it is between economic democracy and financial oligarchy. This is the
struggle that classical economics set out to arrange and quantify in order to
design an appropriate cure aimed at creating amore equitable society and doing
away with “false” and unnecessary rentier costs of
production. Today’s neoliberalism is just the
opposite: it seeks to load economies down with debt extracting interest beyond
their ability to pay, and then demands privatization of public infrastructure
to create monopolies to serve as further rent extraction.

This is what the European Troika has
demanded of Greece. Its product is austerity, and it threatens to impose a new
economic Dark Age.

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The
Levy Economics Institute Working Paper Collection presents research in progress
by Levy Institute scholars and conference participants. The purpose of the
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professionals.

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